The reform of the Spanish electricity sector

The reform of the Spanish electricity sector
In this article, we analyze the measures included in the new Royal Decree being prepared
by the Government, with the aim of ending the tariff deficit of the Spanish electricity sector,
in other words, the difference between the electricity companies´ receivables and end-user
tariffs. The reform is mainly focused on adjustments to the remuneration for renewables energies
and the introduction of a toll on self-consumption. The new rule will also modify the current
auction system for determining the cost of electricity for consumers.
The electricity sector suffered a fall in demand of
2.3% in 2013, in addition to a decline of 1.5% in 2012
(Table 1). The dependence of demand on industrial
consumption explains the larger decline in electricity
demand relative to GDP for the first time since 2009.
Falling demand has adverse consequences on the
financial sustainability of the system, as more than
half the sector’s costs are fixed. The fact that this
demand contraction continued into the first two
months of 2014 –demand is down 0.8%, adjusted
for calendar and temperature factors– is worrisome.
Output under the special regime (renewable
energies, co-generation, waste plants) increased
by 8.1%, bringing its share of output up to 30.2%,
1
Partners at A.F.I. – Analistas Financieros Internacionales, S.A.
compared to 25.5% in 2012. Output from strictly
renewable energies increased by 14.3%, mainly
due to meteorological conditions, as installed power
only increased by 2% in 2013.
Bearing in mind that 61% of renewable energy
output comes from wind, which is unpredictable
and irregular, the system is approaching the limit
of its capacity to absorb renewable energies. In
fact, in 2013, Red Eléctrica, the system operator,
had to manage hours in which high levels of wind
and hydraulic output coincided with extremely low
demand, thus forcing a cutback in output even in
nuclear plants.
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The electricity tariff deficit of 2013 is expected to have reached 4.5 billion
euros, below the 5.6 billion euros deficit of 2012, mostly due to energy taxes
which entered into force on January 1st, 2013. Including the 2013 result, the
accumulated debt stock is projected to rise above 30 billion euros. Recent
regulatory measures aim to correct this imbalance through a deep cutback in
revenues from renewable energies, but not without generating uncertainty over
Spain´s investment climate, as well as the need for renegotiation of outstanding
debt tied to renewables projects.
Vol. 3, N.º 2 (March 2014)
Arturo Rojas and Pablo Mañueco1
Arturo Rojas and Pablo Mañueco
Table 1
Peninsular annual energy balance
Vol. 3, N.º 2 (March 2014)
GWh
2013
SEFO - Spanish Economic and Financial Outlook
2012
% 12/11
2011
Hydro
34,205
75.8
19,455
-29.4
27,571
Nuclear
56,378
-8.3
61,470
6.5
57,731
Coal
39,792
-27.3
54,721
25.8
43,488
Combined cycle
25,409
-34.2
38,593
-23.9
50,734
Gross production
155,785
-10.6
174,240
-2.9
179,525
Self-consumption
-6,241
-20.9
-7,889
8.9
-7,247
Hydro
7,095
53.1
4,633
-12.5
5,294
Wind
53,926
12.0
48,103
14.2
42,105
Solar photovoltaic
7,982
2.3
7,803
10.0
7,092
Solar thermoelectric
4,554
32.3
3,443
87.9
1,832
Renewable thermal
5,011
5.6
4,729
10.4
4,285
Non-renewable thermal
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% 13/12
32,048
-4.3
33,442
4.3
32,051
Special regime
110,616
8.1
102,152
10.2
92,660
Net production
260,160
-3.1
268,503
1.3
264,938
Pumped storage consumption
-5,769
14.9
-5,023
56.2
-3,215
Peninsula-Balearic interc.
-1,266
International exchanges
Demand (at power station busbars)
-570
-500
-6,958
-37.9
-11,200
83.9
-6,090
246,166
-2.3
251,710
-1.5
255,633
Source: Red Eléctrica.
Table 2
Year-on-year GDP and electricity demand
in mainland Spain
Year
GDP
Electricity
demand
2008
0.9
1.1
2009
-3.7
-4.7
2010
-0.3
3.1
2011
0.4
1.9
2012
-1.4
-1.5
2013
-1.2
-2.3
Sources: INE and REE.
The excellent rain year of 2013 decimated
coal and natural gas energy output, which fell
by 27% and 34%, respectively. With such low
consumption levels, combined-cycle plants face
a difficult operating environment. Combined
cycle output is at its lowest in ten years, and
installed capacity ten years ago was only 17% of
the current level. Utilization in 2013 at full charge
of 1,000 hours of combined-cycle plants versus
4,280 hours in 2008 and the 5,000 hours for
which they were designed, is utterly insufficient to
achieve profitability on an investment which has
a useful life period of 25 years. Not even capacity
payments, which are received irrespective of
output, can make up for such severe under-use
of the 25,353 MW of combined cycles, all built
since 2001.
The reform of the Spanish electricity sector
Electricity Industry Act 24/2013
The Electricity Industry Act 24/2013, of December
26th, 2013, acknowledges the inability of previous
measures to end the revenue deficit. Financial
balance is finally to be attained by allowing
greater flexibility in the remuneration of regulated
activities, especially renewable energies, in order
to adjust to changes in the electricity system and,
in particular, to trends in the economy. Spain has
therefore moved away from a sound and stable
system that was predictable in the long term, and
Spain has moved away from a sound and
stable system that was predictable in the long
term, and adopted a flexible model that will be
subject to review every three years.
Law 24/2013 mandates that system revenues will
be sufficient to cover all the costs of the electricity
system, and it imposes on itself budgetary
balance for any regulatory measure related to
the electricity industry. From now on, an increase
of costs for the electricity system or a reduction of
revenues must include an equal reduction in other
cost items to ensure system balance. Hence, it
relies on automatic mechanisms in toll revisions
to correct any deficits that should arise.
Vol. 3, N.º 2 (March 2014)
The tariff deficit of 2013 is expected to reach 4.5
billion euros, but it will fall short of the 5.6 billion
euros deficit of 2012. In 2013, the reduction in
the deficit was due to the taxes on energy which
entered into force on January 1st, 2013 and whose
purpose is to reduce the deficit subtracting income
from generation activity. The 2013 deficit will be
added to the accumulated debt of 26.1 billion
euros, announced by the Spanish National Energy
Commission, as of May 10th, 2013. Eliminating the
annual deficit would require a 10% increase in
the price of electricity, in a manner that is linear
for all consumers, and a hike of somewhat more
than 30% in access tolls, which are part of the
tariff determined by the Ministry of Industry. This
would come in addition to the 22% increase in tolls
between 2004 and 2012, which has driven the
price of electricity in Spain far above the European
Union average. Reducing the accumulated deficit
will require a recovery in electricity demand.
adopted a flexible model that will be subject to
review every three years.
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Tolls on self-consumption
One controversial aspect of Law 24/2013 relates
to self-consumption of customers connected to
the electricity grid, who are obligated to contribute
to covering system costs and services in the
same amount as other consumers. That is, a kWh
produced by a consumer will accrue the same toll
payment as a kWh purchased from the grid. Both
the National Energy Commission and the National
Competition Commission have come out against
self-consumption tolls, but the Ministry of Industry
has decided to avoid the flight of consumer demand
that would be caused by the incentive to save on
the tolls. Only about 40% of the cost of electricity
corresponds to market generation cost. Hence,
if tolls need not be paid, the self-consumption
saving would be substantial. For the Ministry
of Industry, the economic burden of the annual
deficit payments and of aid to renewable energies
must be borne by all consumers connected to the
grid in proportion to their electricity consumption,
irrespective of the self-consumption component.
A decrease in demand from self-consumption in
SEFO - Spanish Economic and Financial Outlook
Nuclear plant output fell by 8.3% in 2013, the
lowest level since 2009. Because nuclear
technology is the only one that does not receive
capacity payments, the fall in output is fully
carried over to the income statement. Similarly,
nuclear energy revenue has fallen as a result of
the new taxes introduced by Law 15/2012, of tax
measures, which entered into force on January
1st, 2013: the tax on the value of production
(equivalent to 7% of revenue) and two new taxes
on production and storage of spent nuclear fuel
and other radioactive waste.
Arturo Rojas and Pablo Mañueco
addition to the fall in demand for electricity due
to the economic crisis would make it impossible to
balance the sector’s revenues and costs without
asking consumers to bear a larger burden, which
would create an even larger incentive for selfconsumption.
Vol. 3, N.º 2 (March 2014)
Voluntary price for small consumers
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54
Law 24/2013 creates a Voluntary Price for
Small Consumers, which replaces the old lastresort tariff, except for consumers considered
vulnerable, who can benefit from a social voucher,
or for customers who, temporarily, have no current
supply contract with an operator.
The last-resort tariff (TUR in its Spanish initials)
is the maximum price that can be charged by
operators designated as last-resort suppliers
to entitled consumers. Until 2013, the TUR was
determined by adding supply and access toll
costs to the estimated cost of electricity through
CESUR (Energy Contracts for the Supply of Last
Resort) auctions.
In December 2013, the invalidation of the CESUR
auction revealed the extra cost the auction system
added to the last-resort tariff. Hence, consumers
can save by turning directly to the deregulated
market.
The name and conceptual change introduced
by Law 24/2013 relating to the TUR is positive,
as a regulated price is always an obstacle to
market deregulation. Hence, the protection of a
minimum benchmark price should be applied
mainly to vulnerable customers. At the same
time, mechanisms must be set up for suppliers
to have incentives to buy energy at the lowest
possible price, and for this price to be passed on
to customers. Precisely one of the problems of the
CESUR auctions was that forward purchases of
energy took place through intermediaries.
Voluntary prices for small consumers will be
uniform through the country: that is, in both the
mainland and in offshore Spanish territories. That
means tacit maintenance of subsidies for the
islands, where the cost of production is greater
than on the mainland. Voluntary prices will be set
by the Ministry of Interior, but their calculation will
observe the principle of income sufficiency, and
the additive nature of costs, and the process will
be monitored to prevent distortions in market
competition. The voluntary price for small
consumers will additively include the following
items in its structure:
■■The production cost of electricity, which will be
determined on the basis of market mechanisms
in relation to the average price forecast in the
market of output during the regulatory period,
and it will be subject to revision irrespective of
other items.
■■Access tolls and applicable charges.
■■Supply costs.
The Ministry of Industry will have to define the new
mechanism for calculating the cost of production,
having ruled out the previous model of the
CESUR auction. The aim is to minimize market
fluctuations, but the cost of energy must also
adequately reflect the costs of the defined period.
If the time horizon is long –for example, three
months, as in the previous CESUR auctions–
the demand volume risk assumed by leading
operators would be larger, and this cost has to
be compensated to suppliers. An alternative for
a quarterly period may involve combining several
auctions with the futures market prices of the OMIP,
the Iberian Energy Derivatives Exchange. A single
quarterly auction, like the CESUR auction, is not
advisable, because the result may be affected
by atypical circumstances that distort the price,
as was the case in December 2013. With three
forward auctions carried out every month in the
preceding quarter, the entire quarterly generation
price would not be linked to the market conditions
of just one day. The forward market is also a
useful reference point for the generation cost to
be allocated to the voluntary price. Both OTC and
OMIP forward electricity markets in Spain operate
The reform of the Spanish electricity sector
The auction mechanism can cover suppliers’
market price risk, as fixed price sellers assume
the risk. If the daily market price is lower than the
auction price, sellers receive the difference and,
conversely, if the market price during the period
is higher than the auction price, the seller covers
the difference.
Remuneration of renewable energies
In the initial period of renewable energy regulation,
the Government sought the promotion of such
energies, starting with the Electricity Sector Act
54/1997 of November 27th until Royal Decree
661/2007. In the second period, from 2009, a 4.7%
fall in electricity demand on the mainland revealed
the need to rein in the increase in capacity.
One of the cornerstones of the reform of the
electricity sector is the reformulation of
the remuneration of renewable energies.
From 1998 to 2008 –that is, in the ten years prior
to the economic crisis– installed capacity under
the Special Regime, which includes renewable
energies and co-generation, increased by a
cumulative average of 17%. In the same period,
mainland electricity demand increased at an
average pace of 4% year-on-year. Between
2008 and 2012, with a less favorable regulatory
framework, the capacity of the special regime
slowed down its average growth rate to 7% yearon-year, but demand contracted by 1.3% on
average every year.
Following the tax measures on energy introduced
in 2013, which had the greatest impact on
conventional energy, and the downward revision
in 2012 of remuneration of distribution activity, the
largest adjustment of the new regulation for 2014
is aimed at the Special Regime.
The draft Royal Decree unveiled the new
methodology for determining facility revenue, as it
constitutes a radical departure from the previous
regulation. One of the frequent criticisms of the
Spanish renewables model was that it awarded
the same remuneration of all facilities of the same
technology, wind or solar, regardless of the fact
that returns varied widely, especially in wind. A
good wind site achieves in excess of 3,000 hours
of yearly production, while the average aggregate
production of mainland facilities amounted to
2,380 hours. The same remuneration per kWh for
all wind farms, regardless of their level of output,
was a clear incentive for developers to seek out
the best sites. There is no doubt that the growth of
wind and solar facilities would not have been quite
as strong without the incentive of capitalizing on
the most attractive sites in the form of higher
revenues.
Spain’s leadership in developing certain
technologies for electricity production based on
renewable sources was possible thanks to the
existence of a sound and stable –and, above all,
predictable– economic and legal framework. It
established the price of electricity for the entire
lifetime of the facility, that is, between 20 and 25
years, based on an initial price that would have
been revised with CPI less 0.25%, initially, and
less 0.50% from 2012.
Vol. 3, N.º 2 (March 2014)
As with the last-resort tariff, the energy cost of
the voluntary price will have to be established,
adjusted for the different consumption time profile
and the cost of adjustment services.
Premiums on the market price of renewable
energies, co-generation and waste management
energy, amounted to approximately 9 billion
euros in 2013. Although this amount represents
a slowdown to 5.5% growth from 24.2% in 2012,
the Ministry of Industry believes that a drastic
reduction in aid to such energies is unavoidable
in order to achieve a re-balancing of electricity
sector revenues and costs.
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with a high level of liquidity, and the mechanism
would be accessible to all suppliers.
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Following the steep fall in electricity demand in
2009, Royal Decree 1614/2010 laid down the
first limit on the number of production hours with
entitlement to the premium. For wind facilities, a
maximum of 2,589 hours a year was set, provided
the aggregate system average exceeded 2,350
hours. But at the end of 2010, some 86% of
current facilities were already in operation. So
the limitation on the number of hours could not
have been taken into account at the time of the
investment decision.
The initial long term certainty about the price at
which a kWh of renewable energy was going be
sold cleared the way for transactions in which the
seller could make significant gains, as long as
the plant had a few years in operation in order to
prove average output.
Instead of a guaranteed price that would be
updated on an annual basis according to inflation
less 0.5%, the new regulation is going to guarantee
a reasonable before-tax return throughout the
regulatory lifetime of the project. The facility’s year
of operating authorization will be a key factor, as
the reasonable return is measured from that date.
The new regulation on remuneration of
renewable energies will be comprised of the
market price of the energy plus a rate per unit
of installed power that covers the investment
costs that cannot be recovered and an
operating rate that covers the operating costs
that cannot be recovered.
Reasonable before-tax return is set at 7.398%,
which is the average return between July 2003
and June 2013, of 10-year State bonds plus 300
basis points.
When the new regulation is approved,
remuneration of renewable energies will be
comprised of the market price of the energy plus
a rate per unit of installed power that covers the
investment costs that cannot be recovered and
an operating rate that covers the operating costs
that cannot be recovered. Investment costs are
determined by the facility type based on a standard
value of the initial investment in an efficient and
orderly business.
The new regulation states that its aim is to
increase legal certainty for a reasonable return,
but it does not extend the same certainty to
foreseeability of cash flows, as the draft Royal
Decree provides no certainty about long-term
prices, as the parameters are periodically revised.
Six-year regulatory periods are established for
revisions, with the first ending on December 31st,
2019, and such periods are divided into three subperiods of three years. That is, the parameters for
calculating revenue may change again in 2017.
The only defined parameters not subject to
revision in regulatory periods are two: the useful
life and the standard value of the initial investment.
Hence, reasonable return may be revised upwards
in the long term if conditions in the sector improve.
A rate of 1% will be used in revising operating
costs from 2014, instead of CPI or, from 2013,
core inflation (which does not include changes
in the prices of unprocessed foods and domestic
fuels), less an efficiency factor, except for items
whose evolution is already regulated (tolls, 7% tax
on revenue effective from 2013).
While the previous regulation set overall
remuneration for each type of renewable energy
(i.e., wind, photovoltaic, thermal solar), the
proposed new regulation assigns to each facility
different income levels on the basis of its specific
characteristics. For example, for photovoltaic
facilities built under Royal Decree 661/2007, the
new regulation will take into account the specific
technology installed (fixed panels or tracker panels
with one or two axes), a factor that was irrelevant
under the 2007 regulation. For photovoltaic
facilities built under Royal Decree 1578/2008, the
The reform of the Spanish electricity sector
Another novel aspect is the increase to 30 years of
regulatory useful life of photovoltaic facilities, instead
of the 25 years in which the highest remuneration
was guaranteed in the initial regulation (Royal
Decree 661/2007), or the 28 years that were
established from 2011 (Royal Decree-law 14/2010).
By increasing the number of years, the regulation
reduces the amortization of the recognized
investment and nominal revenue is lower, in
exchange for maintaining the revenue flow for
five more years. For thermo-solar plants and wind
farms, the useful life remains the same in the period
of higher revenue under the previous regulation, 25
and 20 years, respectively.
In the proposed new regulation, the combination
of different categories of renewables –cogeneration, wind, solar, hydroelectric, biomass,
waste– with the characteristics of each facility
–specific technology, start-up year, tender call,
climate zone, hours of operation– results in 1,276
facility types, each with specific remuneration to
achieve the reasonable return.
The degree of detail of renewable facilities
introduced by the proposed new regulation is
one of its weak points, as it ignores the fact that
current investors –in the vast majority of cases–
are not the ones who made the initial investment.
Transactions between investors were made in
accordance with the characteristics and specific
performance of each facility. Hence, buyers paid
a higher price for facilities that achieved higher
returns on the initial investment. As no returns are
guaranteed on the amount of such investment,
investors that purchased the best-performing
facilities –and, thus, paid for goodwill– are going
Under the new regulation, revenues from
renewable energy facilities are going to decline
considerably, in some cases by nearly 50%. To
the extent that these projects involved a high
degree of financial leverage, the debt must be
restructured and the repayment period extended
in order to adjust debt service to the new revenue
levels. From a financing point of view, renewable
projects remain viable because of their high
cash generation capacity, as fuel is free, and, in
photovoltaic facilities, the addition of another five
years of useful life will allow for paying off the
totality of the debt. However, owners’ expectations
are to lose the entire investment. Share value will
be reduced to the value of options if the recovery
of demand allows for improving remuneration in a
more-or-less distant future.
Conclusions
The Ministry of Industry is prepared to resolve the
annual tariff deficit through a deep cutback in
the revenue from renewable energies. The effort to
homogenize facilities in terms of initial investment,
operating costs and the characteristics of each
plant will mean that the most profitable facilities
under the previous regulation will see the largest
loss of revenue. It would have been difficult for
the Ministry to take into account, when applying the
principle of reasonable returns, the amount paid
by current facility owners, as this amount was
higher than the initial theoretical investment in
most cases. Investors that have paid for goodwill
will have to amortize it and recognize the loss on
their books. Debt-financed facilities will be unable
to meet their repayment schedule, although the
long remaining useful life will allow banks to
recover both principal and interest. Owners now
face battles on two fronts: the first is the court claim
brought against the abandonment of the legal
framework in which investments were made, as
Vol. 3, N.º 2 (March 2014)
Revenue to obtain reasonable return will not take
into account regional taxes. At present, three
Spanish regions –Castile La Mancha, Castile
Leon, and Galicia– levy a surcharge on wind
production.
to receive actual returns far below the reasonable
level. In contrast, investors that purchased worseperforming facilities can obtain near-reasonable
returns, as they did not pay for goodwill.
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return will take into account the technology and
the geographic area in relation to solar radiation.
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no renewable energy facility would have been built
or financed without a certain outlook of sufficient
remuneration over the long term. The second is
the negotiation of debt conditions with financial
institutions, with the aim of preventing default on
payment of debt service, resulting in enforcement
of guarantees and repossession of facilities by the
bank. In this regard, a positive step can be seen
in Royal Decree-Law of March 2014, with urgent
measures to facilitate debt refinancing, aimed at
assisting viable enterprises in renegotiating their
debt through haircuts or conversions of debt into
capital. Undoubtedly, enterprises with reasonable
returns guaranteed by the Ministry of Industry
must be considered viable.